Financial Statement Analysis

Question 1

Financial statement analysis

Answer 1

Inference of information from a company’s financial statements in order to make an economic decision based on the obtained information.

Question 2

International Organisation of Securities Commissions (IOSCO)

Answer 2

An international organisation which coordinates securities and futures regulations and provides benchmark principles for securities regulations. It has over 100 member countries.

Question 3

Role of financial statement analysis

Answer 3

Using information in the financial statements, along with additional information, to make an economic decision.

Question 4

Standard content of a report by external auditors

Answer 4

1) Statement that it is the responsibility of the management to prepare the accounts

2) Statement that the financial statements were properly prepared with respect to applicable standards of financial reporting (Reasonable assurance that the statements are free from material error and misstatements)

3) Accounting principles and estimates used to prepare the reports are reasonable

4) Presentation and discussion of key audit matters, i.e. key accounting choices used

Question 5

Standard-setting bodies

Answer 5

Professional organisations of accountants and auditors that establish financial reporting standards.

Question 6

Role of financial reporting

Answer 6

Presenting a company’s financial performance to interested parties.

Question 7

Regulatory authorities

Answer 7

Government agencies that have legal authority to enforce compliance with financial reporting standards.

Question 8

Proxy statement

Answer 8

Statements issued to shareholders when there are matters that require a shareholder vote.

Question 9

Financial statement notes (footnotes)

Answer 9

Include disclosures that provide further details about the information summarized in the financial statements. They allow users to improve the assessments of the amount, timing, and uncertainty of the estimates reported in financial statements.

Question 10

Form S-1 (SEC)

Answer 10

Registration statement filed before the sale of new securities to the public.

Question 11

Form 10-K (SEC)

Answer 11

Required annual filing which includes information about the business, risks, and its management, audited financial statements and disclosures, and disclosures about legal matters involving the firm. The equivalent is 40-F for Canadian issuers and 20-F for other foreign issuers listed in the USA.

Question 12

DEF 14A

Answer 12

A proxy statement filed with the SEC

Question 13

Form 10-Q (SEC)

Answer 13

Required quarterly form with updated interim financial statements (unaudited), and disclosures about significant events (ex. significant legal proceedings, changes in accounting policies etc.). Foreign companies listed in the USA are typically required to file the equivalent Form 6-K semiannually.

Question 14

Form DEF-14A (SEC)

Answer 14

In the time of publishing a proxy statement, filing of the proxy statement in the form of Form DEF-14A to the SEC is required as well.

Question 15

Form 8-K (SEC)

Answer 15

Filing disclosing significant material events including significant asset acquisitions and disposals, changes in management or corporate governance, or matters related to its accountants, financial statements, or the market in which the securities trade.

Question 16

Form 144

Answer 16

Notifying the SEC that the company intends to issue securities to certain qualified buyers without registering the securities with the SEC. Ie. this is to show the sale of unregistered stock in the company.

Question 17

Forms 3, 4, and 5

Answer 17

Involve beneficial ownership of securities by a company’s officers and directors.

Question 18

Business segment (operating segment)

Answer 18

Portion of a company that accounts for more than 10% of the company’s revenues, assets or income. It is distinguishable from a company’s other lines of business in terms of the risk and return characteristics of the segment. Reported segments should account for at least 75% of the firm’s external sales.

Question 19

Geographic segment

Answer 19

Portion of a company that accounts for more than 10% of the company’s revenues, assets or income. It is distinguishable as a portion of a company which operates in a geographic region which has a business environment different from the other segments. Reported segments should account for at least 75% of the firm’s external sales.

Question 20

Audit

Answer 20

Independent review of an entity’s financial statements with the objective of providing an opinion on its fairness and reliability.

Question 21

Unqualified opinion (unmodified opinion or clean opinion)

Answer 21

Auditor opinion that indicates that the auditor believes the statements are free from material omissions and
errors.

Question 22

Qualified opinion

Answer 22

Opinion given by an auditor explaining exceptions to the accounting principles made (if these are made).

Question 23

Adverse opinion

Answer 23

Opinion given by an auditor if the statements are not presented fairly or are materially nonconforming with accounting standards.

Question 24

Disclaimer of opinion

Answer 24

Opinion given by an auditor if the auditor is unable to express an opinion (e.g., in the case of a scope limitation).

Question 25

Internal controls

Answer 25

Processes by which the company ensures that it presents accurate financial statements.

Question 26

Unearned revenue

Answer 26

A liability created at the time when cash or other payment is received before the transfer of goods and services which an entity gives in return for the payment.

Question 27

Five steps in recognising revenue

Answer 27

1) Contract identification 2) Identify performance obligations in the contract 3) Determine the transaction price 4) Allocate transaction price to performance obligations 5) Recognise revenue when the entity satisfies a performance obligation

Question 28

Performance obligation

Answer 28

A promise to deliver a distinct good or service.

Question 29

Criteria for satisfaction of a performance obligation (each is a sufficient condition)

Answer 29

1) Customer receives and benefits from a good/service over time as supplier meets the contract obligation 2) Supplier enhances an existing asset or creates new asset that the customer controls over the creation/enhancement period 3) Asset has no alternative use for the supplier, and the supplier has the right to enforce payment for work completed to date

Question 30

Bill-and-hold agreements and its revenue recognition

Answer 30

A type of sales agreement that involves the customer paying for goods ahead of shipping. Typically, when a customer pays ahead of delivery, the revenue is treated as deferred, but revenue may be recorded before shipping if the supplier can demonstrate that its performance obligations are complete and the customer has control over the good.

Question 31

Expense recognition principle under the accrual method of accounting

Answer 31

Expense recognition is done in the period in which the economic benefits of the expenditure are consumed.

Question 32

Matching principle (expense recognition)

Answer 32

Expenses to generate revenue are recognized in the same period as the revenue

Question 33

Capitalization (expense recognition)

Answer 33

An application of the matching principle whereby costs are initially capitalized as assets on the balance sheet and then expensed, using depreciation or amortization, to the income statement over the asset’s life as its benefits are consumed. Examples are PP&E and intangible assets.

Question 34

Period costs

Answer 34

Expenses that cannot be directly tied to revenue generation. Examples are administrative costs. This is related to the method of "expensing as incurred" in expense recognition.

Question 35

General rule in expensing vs. capitalisation trade-off

Answer 35

An expenditure that is expected to provide a future economic benefit over multiple accounting periods is capitalized; however, if the future economic benefit is unlikely or highly uncertain, the expenditure is expensed in the period incurred.

Question 36

Operating cash flow

Answer 36

Net income + non-cash charges - working capital investment

Question 37

Research cost

Answer 37

Costs aimed at the discovery of new scientific or technical knowledge and understanding.

Question 38

Stock dividend

Answer 38

A distribution of additional shares to each shareholder in an amount proportional to their current number of shares.

Question 39

Unusual or infrequent items

Answer 39

Events that are either unusual in nature or infrequent in occurrence and are material (significant enough to affect the opinions of financial statement users).

Question 40

Discontinued operation

Answer 40

An operation that management has decided to dispose of, but either has not yet done so, or has disposed of in the current year after the operation had generated income or losses.

Question 41

Prior-period adjustment

Answer 41

A reported correction of an accounting error made in previous financial statement s. It requires retrospective application.

Question 42

Stock split

Answer 42

Refers to the division of each “old” share into a specific number of “new” (post-split) shares.

Question 43

Common-size income statement

Answer 43

An income statement format which expresses each category of the statement as a percentage of revenue. This aids in profitability comparisons.

Question 44

Intangible assets

Answer 44

Non-monetary assets which lack physical substance.

Question 45

Identifiable intangible assets

Answer 45

Intangible assets which can be acquired separately or are the result of rights or privileges conveyed to their owners. Examples are licences, patents, concessions.

Question 46

Unidentifiable intangible assets

Answer 46

Intangible assets which cannot be acquired separately and may have an unlimited life span.

Question 47

Amortized cost (for held-to maturity debt securities)

Answer 47

Original issue price minus any principal payments, plus any amortised discount or minus any amortised premium.

Question 48

Conditions for capitalising development costs (IFRS)

Answer 48

1) The project must be technically feasible 2) The resources to complete the project are existent 3) A market exists for the developed product 4) The company has the intention and resources to complete the project and sell its final results

Question 49

Recognition and treatment of non-controlling equity investments under IFRS

Answer 49

1) Held at amortised cost if value cannot be measured reliably and/or the security is not listed 2) If there exists an active market or a reasonable estimate of value, the procedure is as follows: - The default is that it is held as a Security measured at fair value through profit and loss - The company can make an irrevocable decision to measure is as a Security measured at fair value through other comprehensive income

Question 50

Recognition and treatment of non-controlling equity investments under US GAAP

Answer 50

1) If the instrument is unquoted, it is measured and recognised at amortised cost. 2) If the instrument is quoted, is is classified as a trading security, and its treatment is identical to Securities measured at fair value through profit and loss.

Question 51

Recognition and treatment of debt securities investments under IFRS

Answer 51

1) If there is intent to hold the debt securities to maturity, they can be held as Securities measured at amortised cost. 2) If the security is acquired with the intent to collect interest payments but sell before maturity, it is to be held as a Security measured at fair value through other comprehensive income. 3) If the security is acquired with the intent to sell them in the near term, it is to be held as a Security measured at fair value through profit and loss.

Question 52

Recognition and treatment of debt securities investments under the US GAAP

Answer 52

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Question 53

Securities measured at fair value through profit and loss (IFRS) / Trading securities (GAAP)

Answer 53

BALANCE SHEET - Shown at fair value, all changes in it are shown in the income statement INCOME SHEET - All changes in fair value are classified as either realised or unrealised P&L, dividends or interest goes in as income. Under IFRS, the company can elect to make an irrevocable decision to carry any instrument via this valuation method. Under IFRS, any security which does not fit into the rest of the categories for valuation method, goes automatically into this category.

Question 54

Securities measured at amortised cost (IFRS) / Held-to-maturity securities (GAAP)

Answer 54

BALANCE SHEET - Shown at amortised cost INCOME STATEMENT - Interest income goes into the financial result

Question 55

Securities measured at fair value through other comprehensive income (IFRS) / Available-for-sale securities (GAAP)

Answer 55

BALANCE SHEET - Show at fair value, OCI reserves formed for unrealised gains and losses INCOME SHEET - Interest or dividend income, realised P&L OTHER COMPREHENSIVE INCOME - shows unrealised gains and losses

Question 56

Treatment of loans receivable, notes receivable, derivatives

Answer 56

Loans and notes receivable - IFRS at amortised cost, GAAP at historical cost Derivatives - IFRS and GAAP require measure at fair value through profit and loss, ie. as trading securities

Question 57

Describe the process of calculating the CF from operations (CFO) via the direct method

Answer 57

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Question 58

Describe the process of calculating the CF from operations (CFO) via the indirect method

Answer 58

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Question 59

LIFO Reserve

Answer 59

LIFO Reserve = FIFO inventory value - LIFO inventory value

Question 60

LIFO to FIFO Balance sheet adjustments

Answer 60

FIFO INVENTORIES = LIFO INVENTORIES + LIFO RESERVES FIFO CASH = LIFO CASH - TAX RATE * LIFO RESERVES FIFO EQUITY = LIFO EQUITY + (1-TAX RATE)*LIFO RESERVES

Question 61

LIFO TO FIFO Income sheet adjustments

Answer 61

FIFO COGS = LIFO COGS - d_LIFO RESERVES FIFO TAX = LIFO TAX + TAX RATE*LIFO RESERVES FIFO NET INCOME = LIFO NET INCOME + (1-TAX RATE)*LIFO RESERVES

Question 62

LIFO Liquidation

Answer 62

Occurs when goods sold exceed goods replaced, so older inventories accumulated at lower costs get used up and artificially inflate gross and net income. This can be intentional to mislead, so the analyst should adjust for the liquidation effects by removing them from COGS.

Question 63

Explain the LIFO vs FIFO valuation effects in an inflationary environment via changes in the balance, income, and cash flow sheets

Answer 63

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Question 64

Explain the LIFO vs FIFO valuation effects in an inflationary environment via changes in the balance, income, and cash flow sheets

Answer 64

INC.SH. LIFO_FIFO COGS Higher_Lower EBT Lower_Higher Tax expense Lower_Higher Net income Lower_Higher BAL.SH. LIFO_FIFO Inventories Lower_Higher WC Lower_Higher ROE Lower_Higher CF.SH. LIFO_FIFO CFO Higher_Lower

Question 65

Explain the LIFO vs FIFO valuation effects in an inflationary environment via changes in financial ratios

Answer 65

Profitability ratios: FIFO>LIFO Liquidity ratios: FIFO